Analysis and criticism of America's most prominent public intellectual and champion of Keynesian economics. I am part of the Austrian School of Economics, and I critique Krugman's writings from that perspective.

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Tuesday, July 20, 2010

Is There Really a "Keynesian Case"?

Despair overtakes Paul Krugman. It is so bad that he wants "to stick a pencil" in his eye, which not only would hurt a lot, but also just might blind him and make him even more despairing.

Why this deep, dark depression? It seems that pundits do not "understand" the so-called Keynesian Case, that special set of circumstances which, according to all True Believing Keynesians, justifies government spending sprees, printing of money, and borrowing into oblivion. As Krugman writes:

I’ll be frank: the discussion of fiscal stimulus this past year and a half has filled me with despair over the state of the economics profession. If you believe stimulus is a bad idea, fine; but surely the least one could have expected is that opponents would listen, even a bit, to what proponents were saying. In particular, the case for stimulus has always been highly conditional. Fiscal stimulus is what you do only if two conditions are satisfied: high unemployment, so that the proximate risk is deflation, not inflation; and monetary policy constrained by the zero lower bound.

That doesn’t sound like a hard point to grasp. Yet again and again, critics point to examples of increased government spending under conditions nothing like that, and claim that these examples somehow prove something.

In other words, Krugman is demanding that we meet him on what he considers to be HIS ground. He then takes issue with Tyler Cowen's criticism of "fiscal stimulus" when Cowen uses the experience of Germany in the early 1990s:

1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.

2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.

3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.

In short, it’s hard to think of a case less suited to tell us anything at all about fiscal stimulus under the conditions we now face.

While Krugman never is going to admit that one can legitimately criticize his positions, nonetheless I do believe it is instructive to look into this "special Keynesian Case," better known as the "Liquidity Trap." Because I include Krugman's explanation above about this particular set of circumstances, and even though he does not identify it as a "Liquidity Trap," that is what he is describing.

What, then, does an expectation of rising interest rates really mean? It means that people expect increases in the rate of net return on the market, via wages and other producers' goods prices falling faster than do consumer goods' prices. But this needs no labyrinthine explanation; investors expect falling wages and other factor prices, and they are therefore holding off investing in factors until the fall occurs. But this is old-fashioned "classical" speculation on price changes. This expectation, far from being an upsetting element, actually speeds up the adjustment. Just as all speculation speeds up adjustment to the proper levels, so this expectation hastens the fall in wages and other factor prices, hastening the recovery, and permitting normal prosperity to return that much faster. Far from "speculative" hoarding being a bogy of depression, therefore, it is actually a welcome stimulant to more rapid recovery.

Understand that Rothbard and Krugman are arguing from two very different vantage points. Krugman sees deflation as tragic because he believes that it will lead to a downward spiral in which falling factor prices mean lower absolute incomes, and lower incomes mean less aggregate demand, and the beat goes on.

Rothbard, on the other hand, believes that deflation can be positive because it means that the true relative values of the factors are getting into balance, and are shaking off the distortions that occurred during the inflationary booms. Deflation, in Rothbard's view, means that the previous malinvestments are being cleansed from the system, and that a recovery based upon real values of factors can begin.

Obviously, the two cannot be farther apart. Krugman sees everything in aggregates (Y = C + I + G + [X-M]), while Rothbard views the economy as being a complex web of capital, labor, and other factors in which entrepreneurs are moving resources in ways that they anticipate consumers will desire. For good measure, Rothbard also attacks the entire Keynesian concept of "Liquidity Preference," which is a nice way of saying that during deflation, money increases in value relative to other factors, so that people want to hold more money. Rothbard writes:

The final Keynesian bogey is that people may acquire an un­limited demand for money, so that hoards will indefinitely in­crease. This is termed an “infinite” liquidity preference. And this is the only case in which neo-Keynesians such as Modigliani be­lieve that involuntary unemployment can be compatible with price and wage freedom. The Keynesian worry is that people will hoard instead of buying bonds for fear of a fall in the price of securities. Translating this into more important “natural” terms, this would mean, as we have stated, not investing because of expectation of imminent increases in the natural interest rate. Rather than act as a blockade, however, this expectation speeds the ensuing adjustment. Furthermore, the demand for money could not be infinite since people must always continue consum­ing, whatever their expectations. Of necessity, therefore, the de­mand for money could never be infinite. The existing level of consumption, in turn, will require a certain level of investment. As long as productive activities are continuing, there is no need or possibility of lasting unemployment, regardless of the degree of hoarding.

Indeed, Rothbard believes (and so do I) that there really is an alternative explanation for what Krugman calls a "Liquidity Trap," and that further borrowing and spending by government only will exacerbate the current situation. Like Krugman, I tend to despair, but I am fearful because I believe government is spending and borrowing too much, not to little.

66 comments:

I too am despaired. Despaired at the state of the economics profession.

You see, Prof. Anderson really does not understand Keynesianism. But it’s not surprising since most political hacks disguised as economists do not bother to understand the intricacies of Keynesians, since it is a fairly complicated concept. It’s been apparent on this blog for sometime now that Prof. Anderson has not bother to take the time to understand the intricacies of Keynesianism, and instead relies on others misinterpretations of Keynes to form is own opinion. Today, Prof. Anderson admits for it all to see, he does not understand Keynes, and has probably only glanced at the General Theory over the years.

“I do believe it is instructive to look into this "special Keynesian Case," better known as the "Liquidity Trap."”

This is not a ‘special Keynesian Case’. This is Keynesian. Keynes did not care about recessions. He cared about depressions. You see, Prof. Anderson and others will have you believe (and he has written this many, many times) that Keynes believed wealth and prosperity can always and only be achieved by more government spending, more government debt, and more government printing all the time no matter the circumstances. Of course, this is wrong, wrong, wrong. Politicians and other political hacks disguised as economists have used Keynes as an excuse to increase spending and expand government. This is wrong, wrong, wrong. Keynes, and Krugman, argued for increased deficit spending under very specific conditions, which Krugman calls a liquidity trap. To claim “Krugman sees deflation as tragic” is completely false, since during the deflation of the early 2000’s he very clearly stated fiscal stimulus was not needed to prevent a deeper recession. In fact, he was very publically opposed to deficit spending in the early 2000’s. I know, I know, your response will be he was opposed to everything Bush did and he’s a political hack. That may be so, but he was 100% correct to say the deficit spending in the early 00’s was not necessary. And the deficit spending of the early 00’s was not a Keynsian stimulus. Not one bit.

I know the reality that Keynesian is not a theory based off constant government spending and debt does not fit your ideological stance, but if you are going to critique Keynes, it would be beneficial to all if the critiques stuck to the facts, or at least bothered to study Keynes in depth.

“Krugman sees everything in aggregates (Y = C + I + G + [X-M]), “

Sorry, but this criticism is getting old, and makes no sense. Krugman writes about macroeconomics. Macro economists write in aggregates. To imply Krugman does not view the economy as being a “complex web of capital, labor, and other factors “ is a ridiculous criticism. Find a micro economics blog to critique if you are bored with talking in aggregates.

"Intricacies" of Keynesian "economics"? You have to be kidding. I remember seeing the whole thing put together in mathematical form (complete with trig and multi-variable calculus) in grad school, and I could not believe just how crude the analysis really was.

I'm sorry, but an economy is not something that politicians can plan or somehow "fix" by writing some checks and printing money.

Nonetheless, I am glad you are posting, AP, because I prefer the comment section to be wide-open, including criticisms of my positions.

"I'm sorry, but an economy is not something that politicians can plan or somehow "fix" by writing some checks and printing money."

Not the point. My original comment was in regards to what appears to be a constant misinterpretation of Keynesians, and the circumstances Keynes described in the General Theory. To sum it up as spend, spend, spend, and print, print, print, is 100% not accurate. Of course, my best friend Randall Wray understands how the monetary system operates and he understands the need for deficit spending. And again, he correctly points out that when the government shrinks the deficit, it subtracts from the private surplus. This is not economic ideology. It's basic math.

Let's not forget that early in the Dubya years Krugman was calling for lower and lower interest rates because they allegedly help the housing sector. Krugman seems to think that printing money is ALWAYS the solution. Once printing all that money gets the economy into an unsustainable boom and the bust begins, people are broke and they are not in the mood for borrowing more funny money. The obvious solution, as Prof. Anderson stated, is to allow prices to reconfigure to their real rate. Instead, the Keynesians, without any basis in logic or history, announce that this is the time for the government to incur more debt. Keynesianism is not a complicated theory. It makes no sense whatsoever and Keynesians cannot point to an episode where it actually "worked".

In his blog post, Krugman said:

"If you believe stimulus is a bad idea, fine; but surely the least one could have expected is that opponents would listen, even a bit, to what proponents were saying."

Austrians always listen in detail to what Keynesians are saying. It is the Keynesians who ALWAYS refuse to bother understanding the Austrians. ALWAYS.

"To claim “Krugman sees deflation as tragic” is completely false, since during the deflation of the early 2000’s he very clearly stated fiscal stimulus was not needed to prevent a deeper recession."

He may not have advocated a fiscal stimulus in the early 2000's, but he certainly advocated monetary stimulus to fight a recession (falling prices).

http://blog.mises.org/10153/krugman-did-cause-the-housing-bubble/

In a more recent interview Krugman advocated 2-3% consistent inflation to provide a buffer against deflation (excerpt below);

http://transcripts.cnn.com/TRANSCRIPTS/1007/04/fzgps.01.html

KRUGMAN: That's right. There are a couple of things. One is that - that effect, history resists (ph), in the jargon. But basically, if - if they - if a worker's been out of the workforce for three, four years, it's going to be very hard for that person to get back in. The job references will be bad. The - the experience will - will be lost.

We've seen that happen in European countries that had high unemployment and by the time they finally started to get it down again some of that unemployment have basically become structural, had gotten built in. So that's one thing that's very severe. If we do this - if we don't deal with this now, we may find that 7, 8 percent unemployment is the new normal.

The other thing is that each - each year that we go on like this, we're drifting closer to deflation. You know, the -

ZAKARIA: Explain what that means and why is that dangerous?

KRUGMAN: So deflation is when prices are falling instead of rising.

ZAKARIA: And?

KRUGMAN: And we're - we're actually, you know, most of the way there. We came into this crisis with underlying inflation, around 2.5 percent, which is good. You want a little bit of inflation, gives you more flexibility. That's now down under 1 percent. It quite easily could be negative by the end of next year.

That's bad because when your problem is that people are not spending enough, that there isn't enough borrowing, there isn't enough investment, there isn't enough demand in the economy, deflation -- well, deflation makes holding onto cash, just sitting onto - on idle cash look like an attractive thing to do, and -

Shorter Prof. Anderson: "Math is hard." I am amused by the resistance of Austrian "economists" to the use of modern statistical tools, which they sneeringly refer to as "aggregates". Mathematics is a fundamental tool of science, and by rejecting modern mathematics they thereby prove that they are not members of a branch of science but, rather, members of a religion, complete with a holy canon of Mises, Hayek, and Rothbard each of whose words must be accepted as holy doctrine and never criticized regardless of how little data there is supporting those beliefs.

The fundamental mathematical principle that applies at the zero bounds is the PIGEONHOLE PRINCIPLE. That is, if there are fewer dollars in the economy than are necessary to pay all the employees and buy all the goods, then clearly some of the employees will go unpaid and some of the goods will go unsold. This has nothing to do with mythical appeals to holy canon of Saint Rothbard, but, rather, a fundamental mathematical quality of the universe. If you have five holes and four pegs, it simply is impossible to put pegs in all the holes.

To counter this, Holy Saint Mises and His followers then came up with the theory of "price elasticity". That is, okay, so we have four pegs and five holes, we'll just chop a little piece off of each peg and glue them together to make a fifth peg and fill all the holes that way! The problem is that in a *real* economy, as vs. the fictional economy in the Holy One's scriptures, it took a whole peg's worth of money to create the goods and services available for sale, and no business is going to sell goods for less than it cost to create them. In other words, price elasticity is a crock of BS. When you hit the zero bounds and go into deflation, what happens is that one of those holes is going to go unfilled -- i.e., somebody's going to lose his job, and some goods are going to go unsold.

What Keynesian economics says is that when you hit the zero bounds -- where we are right now -- the solution is simple: Make another peg from scratch to fill that fifth hole. Given that our particular pegs happen to be made of zeros and ones in the mainframe computers of banks, clearly we aren't going to run out of zeros and ones anytime soon. And this is the situation that Keynes was pondering, and which describes the "zero bounds" issue that Krugman was talking about.

Now, neither Keynes nor Krugman proposed making more pegs when there was already sufficient pegs to fill all the holes. When the economy is at full employment then clearly printing more money simply causes inflation (more pegs getting jammed into the holes) rather than an increase in sales and employment (a peg now available for a previously unfilled hole). But given real unemployment in the US is close to 20% if you count the people who've been "disappeared" from the statistics as "not in workforce", can anybody say that this is the situation? Clearly we have holes (goods available for sale) that lack pegs (money available in the economy that can be used to purchase them), otherwise those people (who, remember, are a commodity available on the open market like any other commodity) would be employed!

Note that I talk pegs and holes because if I started talking mathematical induction and proofs then some folks here would start shouting "Heresy! Aggregates!" because, well, math is hard. Needless to say, all this *can* be expressed mathematically in terms that comport with the physical laws of this universe, as vs. of some fictional universe that exists only in the fertile mind of the authors of holy scriptures...

Monetary stimulus is Monetarism, not Keynesian though. Although New Keynesians seem to be more or less be moneterist now. I just find it weird how Austrians call everything Keynsianism no matter what the policy is. Monetary stimulus is something advocated my Milton Friedman, not Keynes. Keynsianism hasn't really been relevant in the US since the late 70s. The Economics profession in the past 30 years has mostly been driven by the ideas of Milton Friedman, not Keynes. It's only recently that Keynesianism is being brought back do to the liquidity trap we're in now, which is the only time it's relevant.

Ah yes, Joe, thanks for bringing that up. Only so much that one can talk about in 4096 characters :). In general, yes, New Keynesians are mostly Friedman-style monetarists... until you hit the zero bounds / liquidity trap. At the zero bounds, any money that is simply issued -- or dropped out of helicopters -- basically disappears under mattresses. That's because there's no incentive to actually lend it since you cannot get any interest income from it. (Note that "saving" money in a bank at the zero bounds is essentially the same as putting it under a mattress, since the bank, for the same reason, will not lend it out but will instead shove it under the Fed's virtual mattresses as reserves).

Note that money under mattresses has essentially disappeared as money. It is no longer pegs out there in "the economy" to use to fill holes. Rather, it's lumpy mattress stuffing, having zero (0) effect upon economic activity happening in the economy.

The fundamental difference between Keynesian economics and monetarism thus occurs at the zero bounds. Until then both tend to have the same goal of printing enough money to match the amount of goods and services in the economy, and a little bit of extra (roughly 2%) to encourage people to move money out from under mattresses and into the economy. But hit the zero bounds, and the Keynesian observation about lumpy mattress stuffing holds -- there is simply no reason to move the money out from under your mattress at that point. The Keynesian then says, "well, given that having all these empty holes err unemployed people around is not good for social stability or the health or welfare of the people, which after all is what an economy is for, we can print the money err make this peg but *directly* put it into the hole via government purchasing decisions rather than just throwing it out of helicopter windows!" That is, are there slack resources in the economy? Is there insufficient money to put those resources to use? Well, print the money and have *government* put those resources to use!

But note that this is only an issue once you hit the zero bounds and have actual slack resources in the economy (as measurable by unemployment statistics). Which is why the stagflation of the 1970's is *not* an example of Keynesianism being "discredited", because that was straight monetarism -- we were nowhere near the zero bounds, and there were no slack resources in the economy, which was at 5% unemployment at the time.

Note that I mention slack resources, and specifically, unemployment. Which is another Austrian fail. While their holy Saint Mises admitted that the unemployed didn't want to be unemployed, most Austrians appear to agree more with their holy Saint Hayek, who claims that the unemployed aren't *really* slack resources (which don't exist in their religious philosophy) but, rather, are taking a long vacation voluntarily. Because, y'see, if they'd only drop their wage demands then they'd get jobs! That despite the fact that the latest statistics show five unemployed people for every one job opening in the U.S. economy... but oh wait, I forgot, there I go with those funny "number" thingies again, and math is hard. Alrighty, then!

I mostly agree with what AP Lerner said, but Krugman does see deflation as "tragic." It's not like it's an uncommon view though. Hayek and Friedman, the two most well known conservatives, saw it that way too.

Of course, a business would sell a product for less than it cost, if the alternative is to take a 100% loss letting it sit in a warehouse. Producers don't set the price consumers do.

Let's say there is a glut of (umm...I dunno) houses. Individuals and banks are quite willing to sell for less than they paid for to reduce inventory and minimize losses.

Keynesians fail to ask why so many businessmen in all sectors of the economy would be such bad forecasters and simultaneously produce more widgets than consumers could actually purchase. Could it be that interest rates set by a central bank and not by the market led producers to believe that there were more resources available than had actually be set aside through under-consumption, and when the inevitable day of reckoning comes employees must be let go and inventory cleared.

The slack resources are the result of the initial malinvestment (fueled by artificially low interest rates) and preventing the reallocation of labor and capital, by bailing out zombie institutions and borrowing from future production to pay people to dig ditches only makes things worse.

One can mathematically model an energy system bound by the laws of thermodynamics. One can statistically model an electron distribution.

However, an economy involves every single market participant making decisions at all times. Can Keynesians model every single economic decision at every instant? Where was the model that predicted the business cycle? Math may be hard, but modeling human action is impossible.

Let's say there is a glut of (umm...I dunno) houses. Individuals and banks are quite willing to sell for less than they paid for to reduce inventory and minimize losses.

Really? And you know this... how? Uhm, are you actually familiar with the housing market right now? I dipped my toe into the water back in April, and swiftly pulled it back out because the situation in the housing market is crazy. Sellers list houses at market prices as short sales. Banks refuse to allow the houses to sell at the prices that the market sets, and insist the houses are worth more than what the offers the seller got say they're worth. The banks haven't gotten a dime of money in payments on these houses for six months, but they figure if they just hold on to these houses long enough, they'll go back up in price. As a result, even though I have the money to buy a house at market prices, the sellers simply refuse to sell them to me at market prices (and in my market, *EVERY* home selling for under $2M is a short sale, with a few repos here and there thrown in but they're cash-only so that's not an option unless you're a dot-com millionaire).

You don't have to take my word for it. Go on the house buying sites like Redfin and Trulia, to their forums, and search for "short sale". You'll find horror story after horror story there. Banks simply aren't interested in selling homes for less than what's owed on them -- or, it seems, even in foreclosing on them. On one home I looked at, it had been on the market for 12 months. In that 12 months the bank had received dozens of offers, but rejected every one of them because it wasn't "high enough". The guy who owned the house had basically abandoned it, it was sitting there with weeds waist-high on me, he hadn't made a payment in over a year, and the bank *still* wasn't interested in selling it for the value that the market set or even in foreclosing on it. If they'd done that, see, they would have had to put a loss onto their balance sheet. That would be bad for their stock price and might attract unwanted attention to the rest of their iffy real estate portfolio. Can't have that, y'know...

The same applies to anything else on the market. If I own a cell phone store and have 1,000 cell phones that cost me $100 to buy from Motorola, and they don't sell worth diddly at $120, I might lower their price to $110... but I won't lower it to $90. That would cause a loss. So I'll just allow my inventory to sell through at the low rate it's selling through at $110 even if it takes six months to do it, and just not buy more inventory when this is depleted (or if the new inventory is at a lower price due to deflation elsewhere in the supply chain, *then* I'll lower the price of the widget). But I'm not in business to make a loss. I'm in business to make a profit. If I have to accept lower volume to make a profit, so it goes.

In the end, price tends to be a trailing indicator of deflation, not a leading indicator. We know this because we have (duh) NUMBERS showing this, all the way back to the Great Depression. Heck, even the *AUSTRIANS* admit that price doesn't always come down during monetary deflation, though they blame government intervention for that (see their critique of Roosevelt's actions, which they blame for keeping wages from falling during the Great Depression... remember, wages are a price). Maybe price is a leading indicator in some universe, maybe one where unicorns are real and cotton candy grows on trees... but every piece of data shows that price is not a leading indicator in this universe, and since this universe is the one we live in...

I guess you missed all of the furniture/equipment auctions after the dot com bust. EToys is still holding onto theirs and letting it "sell through at the low rate" along with the Web site they created. Oh, I guess that happened another universe.

To say a business would not sell for less than something cost is false.

If I could sell a house for a 10% loss then roll the capital into a venture that returned 20%. I'd be ahead 8% overall. Now, if the gov't and the FED stepped in and promised to borrow and print enough to prop up home prices I might hold on to it, even if there was a more profitable venture, but how can I know what's truly profitable with all the market interference.

Anyways, companies sell at a loss all the time to free up capital. It's one of the consequences of poor forecasting.

Say you sold 10 phones for $120, 100 phones for $110 and the rest for $90. You'd take a loss of $7.7K on your initial investment, but if you turned around bought 923 netbooks and were able to sell them all for $120 you'd end up with $10760 net profit, not as good if you had sold all the phones for $120, but hey they weren't moving.

Well gosh, Brian, eToys is just *SO* much like a business that's selling a low volume but making a profit on each sale, and just voluntarily decided to go out of business just because they felt like it, not because they (duh) DIDN'T SELL THEIR STUFF FOR ENOUGH MONEY TO STAY IN BUSINESS.

My point is that most businesses are *NOT* eToys. They don't sell things for less than it cost to buy them BECAUSE THEY WANT TO STAY IN BUSINESS AND THEY CAN'T DO THAT IF THEY BEHAVE LIKE eTOYS. So rather than drop prices below the cost of inventory, they lay off salespeople, negotiate a lower rent with the landlord, or do anything else they need to do to lower expenses so they can stay in business at the lower volume.

This isn't rocket science. This is Business 101 that anybody who has owned and run a small business knows by heart. eToys thought they could take a loss on every sale and make it up on volume. You seem to think the same thing. But real business just doesn't work like that. You advocate the eToys business model for the entire economy -- businesses selling inventory for less than what it cost them to buy that inventory -- and businesses, rightly, are calling that a crock of bull and accepting lower volume (but higher per-unit prices) rather than embrace the eToys business model that you -- and Saint Hayek and Saint Mises of the Church of Austrian Economics -- insist is the only "right" way to run a business. This results in unemployment that Saint Hayek insisted was caused by lazy Germans and that Saint Mises insisted was caused by that mean Mr. FDR (or mean Mr. Obama or Bush I guess in today's economy), but anybody who's ever run a small business (which I have) knows this by heart -- you can't stay in business if you sell your inventory for less than it cost you to buy it!

Jason: You seem to think there is anything out there that's returning higher margins. But in a deflationary environment, there isn't -- because there simply isn't enough pegs (money) to fit in all the holes (goods for sale). So margins on *everything* suck... which is pretty much the case right now for everything but luxury goods (which sell to the people who *do* have the pegs to fill the holes). Nice if you're Apple Computer selling luxury goods for a 30% net profit after expenses. Sucks to be you if you're selling netbooks though -- margins on those things suck the big one.

It was just a simple thought exercise. Bottom lines is bubble activities are unsustainable and Keynesian stimulus only prevents the market from finding sustainable lines of production.

When the market sets interest rates, the rates are low because there is a large supply of savings, meaning people are delaying consumption for a later date and there is a surplus of resources available for entrepreneurs. (i.e. you can order 100 cell phones, because the resources are there, and people are indicating they will buy them eventually)

When the FED sets rates, the rates are low artificially, the resources aren't there and people are not delaying consumption. (i.e. you think you can order 100 cell phones, but when the time comes the consumers don't have the money to spend)

Now you should switch to a sustainable line of production like netbooks and temporarily lay off a salesman, but Keynes tells you to hold onto you cell phones (he wants you to sell them for $120 not $110 or $90...eek deflation), and the gov't will pay your salesman to build bridges, until good times return.

By completely ignoring the initial malinvestment, Keynesian stimulus actually prevents 'good times' from returning by diverting resources from sustainable lines of production to unsustainable ones.

So you're saying that 20% of Americans under or unemployed are in search of full-time work because of "malinvestment"? Could you give us examples of this "malinvestment" that somehow leads people to stop buying and start saving when we hit the zero bounds on interest rates? How does the "malinvestment" make people stop buying, is it like some malevolent magic fairy that bashes people over their head with its magic wand and stops them from buying stuff? How does the "malinvestment" make banks stop lending and start stashing the money under mattresses itself when we hit the zero bounds on interest rates, is it like some Mafia hit-man that goes out and leaves horses' heads in the back seats of banksters' limos?

The bad investments in overpriced housing certainly hurt the economy, but they hurt the economy by causing the collapse of the circulating money supply so there wasn't enough money to buy all the goods and services available for sale, not because some magical Malinvestment Fairy with suspiciously hairy legs started bashing people over the head. And BTW, I was using cell phones as a standin for "the collective inventory of all businesses in the nation". You are correct that businesses adjust inventory to decrease inventory of less profitable goods and increase inventory of more profitable goods, but if you sell all inventory for below its costs, you're out of business -- period. See: eToys. So it doesn't happen -- unemployment happens instead, as businesses reduce costs in order to maintain margins and profits. Which is what has happened, most businesses are still maintaining their pre-recession profit margins, they're just selling at a lower volume. See: the typical 10-Q on file with EDGAR. (You DO read 10-Q's on companies you're interested in adding to your portfolio, right?).

So I'm sorry, given that there's a perfectly reasonable mathematical explanation for the situation, I see no reason to invent fictional ones. Frankly I don't believe in magic malinvestment fairies, just as I don't believe in the tooth fairy or Santa Claus. If you're going to talk about a magic malinvestment fairy, you're going to have to show me at least a photograph of him, 'kay?

Tell me, badtux. Why did our ancestors invent denominational currency in the first place? Was it to solve an equation? Or did it fulfill a necessary function in regard to human economic action? Why do we still use denominated currency? Is there an equation involved that needs to be solved, and no other approach will do?

If you know the answers to the above questions why do you refuse to answer the problem in regard of 'pegs to be plugged' in the form of function, but insist there is an equation to be solved? Also if you do know the answer, you will know that the little riddle you proposed above solves itself.

I note you Keynesians tend to stick to simple linear equations that are better explained in plain English rather than anything that actually involves a little algebra. For good reason. Most equations are unsolvable, and when you factor in 'leakage' your model becomes useless as a vehicle to push policy.

Apologist of other pseudo-sciences, astrology, numerology, and demonology seek to add validity to their claims in terms of a mathematical veneer so it is not surprising Keynesians do the same. Mathematics has a roll in economics obviously, but you push it to do something that it doesn't do in the Hard Sciences, and that is to have an explanatory function, a proof in and of itself. This is also a trait of the above mentioned pseudo-sciences that Keynesian economic theory shares a common lineage.

One of the strengths of the Austrian School is it lacks this pretense, and insists it is a discipline, and not a science.

By the way, this is coming at you from a Hard Science guy with a pretty decent understanding of the work of Haskell and Gödel who finds the explanatory power of Keynesian economics to be underwhelming.

I am amused by the resistance of Austrian "economists" to the use of modern statistical tools, which they sneeringly refer to as "aggregates".

Austrians sneeringly refer to aggregates as “aggregates”. Like “aggregate demand”, which does not exist.

Mathematics is a fundamental tool of science, and by rejecting modern mathematics they thereby prove that they are not members of a branch of science but, rather, members of a religion, complete with a holy canon of Mises, Hayek, and Rothbard each of whose words must be accepted as holy doctrine and never criticized regardless of how little data there is supporting those beliefs.

When a central bank creates money out of thin air, those receiving the new money have stolen purchasing power from those holding the existing money. One knows this a priori. No amount of data collection or statistical analysis or mathematics can refute the obvious. Statistical analysis might help guesstimate how much damage this event might cause, but it does not help describe the nature of the act itself.

People spending this new money are not spending their own savings but those of someone else. This new money artificially bids up prices in the market while the interest rate (the price of loans) has been artificially forced down from its natural rate by the central bank. Since value is subjective and only disclosed by actual purchases in the market, this will make economic calculation quite difficult. It will also induce transactions and investment that would not occur and would not appear profitable without the creation of the new money. It will especially induce long term investments that are not sustainable. Houses will likely be bid up in price with the new money but there really isn’t $800,000 worth of stuff to trade for what was once a $100,000 house. The funny money will lead to a bust. There is no place for statistics in this analysis other than an after-the-fact guide to what precisely is going wrong where. It is secondary to the qualitative analysis.

By the way, Rothbard was a mathematician. Greenspan was a clarinet player.

if there are fewer dollars in the economy than are necessary to pay all the employees and buy all the goods, then clearly some of the employees will go unpaid and some of the goods will go unsold.

What does that mean? Value is subjective. If goods cannot be sold, it is because no one wants to buy them at the price offered. Prior money dilution most likely induced an overproduction of goods because economic calculation was disturbed. People are actually a lot poorer than everyone previously believed, but which they now realize. All that additional money dilution can accomplish at this point is to trick people into accepting lower wages and prices than they might otherwise accept at the cost of further price and investment distortion.

At the zero bounds, any money that is simply issued -- or dropped out of helicopters -- basically disappears under mattresses.

The whole idea of “zero bounds” is preposterous. It is based upon Keynes’ idea of low interest rates inducing a perpetual boom. Instead, low interest rates lead to an unsustainable boom followed by a bust. Yes, once the central bank has dropped interest rates near zero after the bust begins, everyone is too poor to borrow any more money so inducing a further unsustainable boom becomes more difficult. This just leads to the Keynesian “solution” of more and more government debt. There is no basis in fact or logic to think that more government debt induces prosperity. “Mathematics” sure doesn’t help demonstrate an illogical assumption which is not backed up whatsoever by historical events.

Badtux:

Why don’t you march down the street wearing a sandwich board announcing “I don’t know nuttin’ ‘bout no Austrian Economics”?

You seriously don't get malinvestment? The world's scarce resources were squandered.

Lumber and labor squandered on building too many houses. Wealth squandered bidding homes prices into the stratosphere. Clueless investors buying securities backed by those overpriced houses. It spilled over into the rest of the economy as people used their imaginary equity as an ATM and spent imaginary wealth on consumer goods. Firms who provide said goods expanded and wasted even more resources chasing the imaginary wealth of their customers. Long before all that wealth was squandered, wealth was lost bidding dotcoms through the roof. Yahoo bid up higher than the GDP of New Zealand...and so on.

Finally, the whole farce has collapsed and people are holding onto what little real wealth they have, and banks are being very prudent as to what ventures they back (good for them).

People are unemployed because too much labor was directed to bubble activities. People are unemployed because the American consumer has realized their imaginary wealth evaporated and they must now live beneath their means.

Frankly, we need less people working in the 'service' industry and more people working in factories producing stuff that the rest of the world wants to buy.

When a central bank creates money out of thin air, those receiving the new money have stolen purchasing power from those holding the existing money. One knows this a priori. Really? How is this theft? Seeing other people buy and have stuff makes you poorer? In current conditions money creation - targetted at regressive tax reduction or boosting employment or federal aid to state budgets would not cause price inflation. It would just encourage economic activity and promote human welfare. It would increase everyone's real wealth, including that of the purported victims of the "theft."

One can call this "theft" in one's odd econo-religion. But still, the more well-designed "theft" the better then.

People above observe when real Keynesian economics was riding high, and when it was replaced by monetarist /neoliberal quackery. Is it a coincidence that when real Keynesianism and full employment policies were in place, that the world had the greatest economic growth it has ever seen?

"In current conditions money creation - targetted at regressive tax reduction or boosting employment or federal aid to state budgets would not cause price inflation. It would just encourage economic activity"

so let me get this straight, a program that 'encourages economic activity', or demand, doesnt have an effect on prices. ok, i get it now.....

The Malinvestment Fairy was a carpenter? Who coulda known! So, if the Malinvestment Fairy was a carpenter, then in 2006 at the peak of the housing bubble, there would have been shortages of labor in other parts of the economy because everybody was rushing out to build houses. So let's look at January 2006. There's a total of 13,110,000 construction workers out of a nonfarm workforce of 136,086,000 people. This is a roughly 9.6% of the nonfarm civilian workforce. So, was that any different from previous years? Let's look at 2000, when everybody agrees there was no housing bubble. 11,862,000 construction workers out of a nonfarm workforce of 131,785, for a total of, err, 9% of the nonfarm workforce. Wow, that 0.6% change in how many carpenters sure was a huge malinvestment! Whereas the change in economic activity caused by the collapse of housing prices drove unemployment from 4.8% to 9.8% -- i.e., 5% change. So 0.6% too many carpenters building houses turns into 5% more people unemployed? Wow, who could have known that 0.6=5!

Now, for the person asking about where money came from: Money has two fundamental and competing purposes: To foster the exchange of goods and services in a market, and as a store of value. Money must serve as a store of value because otherwise it cannot foster exchange -- money that loses its value between earning it by selling goods and spending it by buying goods is useless -- but the problem is that if money is never used to buy goods because it has been stored under a mattress, then it effectively disappears from the economy. Our problem in our economy right now is that money is disappearing under mattresses and thus ceasing to function as an instrument of market exchange, leaving too many goods and too little money to buy them. The end result is a reduction in the number of goods exchanged in the market -- i.e., exactly what we're seeing on company's 10-Q statements, fewer goods sold, but no price/profit declines.

Bob: Nice religious exposition. I notice you sneering once again at modern statistics, which is all about measuring things like aggregate demand via statistical methods. I'm not going to address this further because it's like talking to a young earth creationist -- the inevitable result is "I have faith that your facts are wrong" complete with reference to "a priori facts" like "the Bible is God's inerrant word so if your 'facts' disagree with the Bible, then your 'facts' are wrong." Dismissing the very basis of the scientific method, which requires testing your models to see if they match actual observed reality, pretty much ends the possibility of a scientific discussion.

And finally: For the record, I am not a Keynesian economist. I do not feel that there is any single economic school whose models are accurate for all situations. At the zero bounds the Keynesian models match observed behavior, and that is why I use the Keynesian models at the zero bounds. In other situations I use whatever model best matches the situation -- even the Austrian model if we were looking at a situation of full employment where government spending was crowding out private spending. Which just goes to say that any school of economics that claims that they have the one and only Truth is full of it, because I have seen no school of economics whose models match observed reality in every situation. 'Nuff said on that.

Ah yes, Burk, you sneaked in while I was writing. Go back to my example of holes and pegs, where holes is available resources in the economy, and pegs is available money in the economy. Right now, the problem is we have too many holes and not enough pegs. If we create more pegs via creating them from zeros and ones then putting them into holes (i.e., fiscal stimulus), we won't have inflation until we have more pegs, i.e., until we reach full employment again, at which point we'll have more pegs than holes and thus end up putting two pegs into one hole (i.e., inflation -- more money than there exists resources in the economy to spend it on, thus something goes up in price, i.e., has more money matched to it in the market). More money, in this model, simply brings more resources off the sidelines and back into the market as sales until we have no idle resources left, at which point inflation begins.

Of course this is not a perfect comparison, because not all resources in the economy are desired by customers -- i.e., even if they *did* have money to spend, they wouldn't buy that particular resource. There's not much demand for buggy whips nowadays. So increasing demand this way (i.e., providing more pegs to put into holes) isn't absolutely guaranteed to not increase the price of some commodity. But as an aggregate whole, the increase in prices will be far less than if the economy were at full utilization and if I sat down with money supply, price inflation, and employment utilization numbers I could produce a model for you that would fairly well describe what you'd expect to see in this situation. (oh no, I used the word "aggregate" again, and made Saint Mises and His holy crusaders cry! Oh well). We're not talking rocket science, after all, just basic spline curve fitting to observed data (OMG! Observed data! Run away, run away!). But even just eyeballing the observed data from the past, it's clear that inflation doesn't start happening on anything other than a trivial basis until you approach full resource utilization in the economy...

One can call this "theft" in one's odd econo-religion. But still, the more well-designed "theft" the better then.

The artificial creation of money is theft and fraud for the same that reason criminal counterfeiting is theft and fraud. If you save $100,000 to buy a house and your next door neighbor prints up $110,000 of counterfeit cash and outbids you for the house, he’s stolen your purchasing power. THAT’S WHY COUNTERFEITING IS ILLEGAL. THAT’S WHY SECTION 19 OF THE COINAGE ACT OF 1792 MADE IT A CAPITAL OFFENSE FOR THE CRIME OF DEBASING COINS AT THE MINT. Your silly name-calling is an admission that you have no serious objection to calling this an obvious act of theft and fraud. The borrower has no money to spend. The bank has no savings to lend.

The Malinvestment Fairy was a carpenter?

So there wasn’t a housing bubble? What a pathetic “argument”. It is self evident that people bought and bid up the price of houses with new funny money. EVEN KRUGMAN UNDERSTANDS THAT"

"Paul Krugman: As Paul McCulley of PIMCO remarked when the tech boom crashed, Greenspan needed to create a housing bubble to replace the technology bubble. So within limits he may have done the right thing. But by late 2004 he should have seen the danger signs and warned against what was happening; such a warning could have taken the place of rising interest rates. He didn’t, and he left a terrible mess for Ben Bernanke."

Not only were new houses built, but old houses were appraised and sold at artificially high prices. PEOPLE BORROWED MONEY AGAINST THOSE ARTIFICIALLY HIGH HOUSE PRICES. They spent money that they really did not have in savings. People were misled into thinking they were richer than they really were. That’s undeniable and you don’t need math to understand that qualitatively. IF FUNNY MONEY DOESN’T INDUCE PEOPLE TO BUY STUFF, WHY CREATE THE FUNNY MONEY? You are the big fan of inducing people to buy stuff. I say just leave them alone.

but the problem is that if money is never used to buy goods because it has been stored under a mattress, then it effectively disappears from the economy. Our problem in our economy right now is that money is disappearing under mattresses and thus ceasing to function as an instrument of market exchange, leaving too many goods and too little money to buy them.

First of all, if people want to hide money under their mattresses, that’s none of your freakin’ business. They are saving for the future. End of story. It’s not your duty to trick them into “buying stuff”. If an entrepreneur has produced more stuff than he can sell profitably, TOUGH LUCK. He’s wasted precious resources and maybe he should find another line of work. I’m sure there’s some price at which he can sell his stock.

Second, you’ve expressed the essence of the Keynesian religion, the infantile belief that “the economy” is a wind-up baby toy stuck in neutral which cannot begin to spin without government “stimulus”, monetary or fiscal. People have different talents, they make stuff and they buy and sell stuff. There is no basis in logic or history to suggest that they require a constant din of funny money based upon theft and fraud to keep the baby toy spinning. Austrians, on the other hand, know that individuals simply cannot attain the requisite knowledge to “run” an “economy”. Because value is subjective, people must be free to bid on goods and services with sound money and the resulting prices express those values as best as possible in this world and allow for economic calculation.

Ah, your math is too narrow. Did you count real estate agents, house appraisers? What about all the teachers, and police hired with the increased property taxes on the imaginary home values. What about the car makers who built all the SUVs that no one wants? What about the baristas in the coffee shop that sprung up down the street from the McMansions?

When you print money and create the illusion of wealth the distortion affects the entire economy. That's how Austrians explain how business across the board can make bad economic decisions at the same time, not silly 'animal spirits'.

Uhm, Jason. Your religion is the one who created the magical Malinvestment Fairy out of thin air. I have the same thing to say to you that I have to say to the young earth creationist: You say your invisible being created this? Well, prove it. Show me a picture of this invisible being. Give me some actual numbers showing that significant resources in the economy were diverted to the housing market by the housing bubble.

Same deal to Bob, who keeps repeating paragraphs out of his holy scriptures and pretending that this proves something other than that he's capable of copying paragraphs out of his holy scriptures. But oh wait, I forget, Bob doesn't even believe in numbers because they're "aggregates" and violate his Holy Scriptures.

Folks: I do mathematical models for a living, in a variety of fields. Do you have a cell phone? The FET in that cell phone that controls the power has a data sheet for use by the engineers that designed it, that comes with a nice chart showing various characteristics at various temperatures. Where did this chart come from? Well, an Austrian would say, "it comes from a priori first principles of physics." Well, except it doesn't. No semiconductor is a perfect semiconductor, and while the physicist who designed the theoretical constructs and told the engineers how to dope it had his own models of semiconductor physics that he was using (a nice model library, BTW, I was quite impressed that a physicist could write software so well), the actual process of manufacturing the semiconductor always introduces some measure of variability that makes it deviate from the theoretical. So how do we provide the engineer with the data on the *real* semiconductor, the one in his hands? Simple. We measure it, then MODIFY THE MODEL TO FIT THE ACTUAL OBSERVED DATA, using a multivariate nonlinear optimization of the model parameters to minimize the difference between observed data and the model by using something like Nelder-Mead. At that point then we can generate those nice graphs for the engineers telling them what the semiconductor does -- because we MEASURED it.

The point being that science is reality-based, based upon what can actually be measured. The model must fit reality, not the other way around. I've found in economics that many of the things we've been talking about can be modeled using the same basic techniques. If you refuse to measure things, and instead wave your hands around and babble nonsense about 'a priori knowledge' and 'aggregate data', then you're not a science. You're a religion.

In the case of the behaviors of economies at the zero interest rate point, we have models that match observed reality. These models roughly approximate Keynesian economics. Some folks don't like that, screaming "Heresy! Malinvestment! Gold! Saint Mises shall strike you down!" Yet of course they provide no such data to support their assertion -- and assert that no such data is possible, much as the young earth creationist rejects all data such as e.g. fission decay products that show the Earth is billions of years old by simply waving his hand and saying "God created the fission isotopes already PRE-DECAYED!" It's a religious belief, and not useful if you're trying to come up with a science that describes *this* universe, not some fictional universe where things are true because Saint Mises said they were a priori truths.

At which point I'm repeating myself. It's been fun trolling the religion board, but I need to get back to my own blog, I dropped in here by accident by clicking the wrong link on a Google search while looking for a graph on Krugman's blog. I do have to say that the conversation, as such, has been amusing and provided me with much fodder for the next few days on my own blog, where I'm not limited by 4096 characters and can actually post graphics with real equations and such (the horror! Oh the horror! ROFL).

As I understand the Austrian viewpoint, they do not reject mathematics nor statistics nor empiricism. That is a strawman.

What they reject is the assumption that these can be applied to economics. Yes, you can use statistical models to predict the motions of inanimate objects, but you will fail to do so when trying to predict the behaviour of humans.

The proof of this is everywhere. Examine the forecasts of the best econometricians in the IMF, the Federal Reserve, Bear Stearns, Lehman Bros, the OECD, the US Govt, or any government, or any economics institution for the past decade or more. Then compare these prognostications with reality.

You do raise a good question: "Give me some actual numbers showing that significant resources in the economy were diverted to the housing market by the housing bubble." Like you, I look forward to seeing the response.

I am a bit puzzled in badtux’s bewilderment that anyone would make the claim that the housing boom caused a malinvestment in resources. I would think record foreclosures and bank failures might provide a ‘measurable’ (plausible?) indication a lot of resources were committed to an area they should not have been.

Perhaps badtux is indicating the same thing Krugman did in a blog post back in Dec. 2008? That since severe unemployment exists nationwide, and the housing bust was only severe in certain states, the housing bust does not explain the recession? This article in response to that Krugman blog post, then, might be of interest;

Bob, show me the math formula from 1999 that will tell me the position of every electron in every ball that Tiger Woods hit in order to win the Masters. If you can't do that, then physics is a lie.

Hint: It's provable that it's impossible to predict micro behavior of individual subatomic particles. Yet we can predict the behavior of entire systems of subatomic particles, which we call "atoms". I.e., if Tiger Woods has a ball that weighs X grams, it's 10 meters from the hole, and the coefficient of friction is Y, I can predict 100% that if he hits it with force Z directly at that hole, it'll go into the hole -- despite the fact that I can't predict the location of any single subatomic particle within the complex system that we call a "golf ball"! Wow, we can't predict micro behavior, but we can predict macro behavior? Clearly that physics stuff is bunk, ignore all those inventions based on physics like this computer you're typing on, clearly you're just imagining that they work and are actually talking to yourself, just as clearly we only *imagined* Tiger Woods winning the PGA because clearly since we can't tell where subatomic particles went, we can't tell where the golf balls made of subatomic particles went either, so there was no score :).

Point: The fact that it is impossible to model micro behavior does not make it impossible to model macro behavior. That irked Albert Einstein considerably, he said with consternation "God does not play dice with the universe!" But eventually even he had to admit that yes, it IS possible for micro behavior to be unable to be accurately predicted *and* for macro behavior to be accurately modeled. And ole Einstein was a lot smarter than Bob, so if he couldn't disprove quantum physics, somehow I suspect Bob can't either...

Richard: Your mistake is that you are confusing money with resources. Resources are things like manpower and lumber and real estate salesmen and houses and such. Money is pieces of toilet paper that we use to foster commerce because otherwise the chains of barters needed to create products with complex intermediary chains would be utterly untenable (same reason why Communism is utterly untenable, by the way -- economic systems are too complex to be accurately modeled at the micro level, thus we use a token "neural network" system to train economies to produce the right mix of intermediaries).

It is provable that for one reason or another, we had too many pieces of green toilet paper with pictures of dead people associated with houses. It is also provable that loans were made to people that were provably impossible to repay given the income of the people who were given the loans. That large amount of toilet paper moving around in the economy is not the same thing, however, as proving that we had too many actual physical houses built and too many people involved in building and selling homes. I'm willing to entertain the notion that this was a problem, but please, proof by assertion isn't going to do it -- can we get some, like, actual real numbers here on how many excess homes got built and how many resources were misallocated into this field, rather than a broad sweeping assertion that it was so?!

Human beings have free will and their behavior cannot be "modeled" like projectiles or engineering projects. There's nothing more to say on this and arguments to the contrary are silly and a waste of time.

Free will is a religious belief, Bob, and has nothing to do with the question of whether macro behavior can be modeled or not. Thus validating my assertion that Austrian "economics" is, at heart, a religious faith rather than a science, and should not be confused with the actual science called Economics, any more than "creation science" should be confused with the actual science called Biology.

Furthermore, "free will", even if it existed (I submit that there is no proof that it does exist as anything other than quantum uncertainty at the subatomic level within the physical neurons of human beings) does not affect the validity of the observation that micro behavior can be unpredictable yet macro behavior predictable. Einstein tried to disprove this observation and didn't manage it. You're no Einstein. 'Nuff said.

Uhm, I already stated that micro events are not in general predictable by models, whether we are talking about specific quantum mechanical events or microeconomic events. I also stated that this makes no (zero) difference in the ability to model macro events. I am sorry that you lack the intellect to understand basic quantum physics, but (shrug). Reality is what it is, regardless of your lack of understanding. The semiconductors that I model work just fine, even if I can't predict the behavior of individual electrons -- your computer is proof of that.

Reminds me of the Austrians who enjoy playing gotcha with me about "how can something be in two places at once?" talking about money. Once again, that demonstrates more a lack in Austrian intellect than in something that violates fundamental laws of nature. In nature, it is quite possible for subatomic particles to be in two places at one time (see the famous quantum interference experiment for an example of that with photons). Furthermore, it is quite possible for something to physically be two things at the same time -- light is both a particle that acts upon substances in discrete quanta, and a wave which interferes with other waves. No, *not* a particle moving in a wave, but both things at once, much as Catholic theology holds that God and Jesus are two different entities, yet the same entity. The fact that a bunch of ignorant shepherds 2,000 years ago could understand such things yet some folks who claim to be "economists" cannot is telling...

Now I here you saying, "but men are not physical things! You can't use the same laws of physics for men!" Really? Funny, I seem pretty physical to me (pokes arm - yep, physically there, yo). Such a statement that men are not governed by the fundamental laws of nature is not sustainable by any scientific evidence, but, rather, is a religious statement. Which is fair, but don't claim that any "economics" based upon religious statements is anything other than religion, just like "creation science" is not science. It's religion. Be honest about it.

Badtux, it's so encouraging to know that you are shooting with blanks. What a pathetic argument, trying to confuse the physics of what might happen to your body if used as a projectile vs. the purposeful action of your infantile behavior in trying to insult Austrians.

Further, I have already stated that statistical analysis can help make educated guesses about future human behavior. Like polling before elections. That has nothing to do with refuting Austrian Economics. Apples and oranges.

Since you admit that "micro" (human) predictions cannot be made, what's the dispute?

Hell, I can usually predict in advance the dumb-ass uninformed desperate anti-Austrian arguments used by blog commenters.

So I'm baffled. You appear to have battered multiple holes in a man of straw -- my inability to model microeconomic behavior -- when neither Krugman nor I have ever stated we could model microeconomic behavior. It's as if you stated that Krugman is a fraud because he did not predict who was going to win the Lotto last week. Uhm, what's that got to do with macroeconomics?!

Oh wait. You don't believe in macroeconomics. Just like you don't believe human beings are subject to fundamental laws of physics. Despite the fact that, err, we have these models, and, err, they've predicted 100% what the course of the current economic recession would be based upon the decrease in effective money supply caused by a collapse in asset values and resulting effect upon the multiplier ratio as banks suspend lending (either voluntarily or because they go under). But nevermind that, look over there, it's an Austrian ostrich! Err, alrighty, then!

BTW, if you're wanting me to produce some models for you, you're SOL. I don't care enough. Go buy a basic macro text, I hear Krugman's reprinting one of his if you're interested in learning some macroeconomics rather than repeating religious scriptures.

"so let me get this straight, a program that 'encourages economic activity', or demand, doesnt have an effect on prices. ok, i get it now...."

Yes, you got it. In depression conditions, Keynesian programs do not have effects on prices. The naive quantity theory of money is empirically wrong. Deficit spending during a depression, especially for rational projects, say like the Triboro bridge in NYC are a complete win-win for everybody. They make everybody richer, happier and don't change prices.

@ Bob Roddis

Me:One can call this "theft" in one's odd econo-religion. But still, the more well-designed "theft" the better then.

Bob Roddis: The artificial creation of money is theft and fraud for the same that reason criminal counterfeiting is theft and fraud. If you save $100,000 to buy a house and your next door neighbor prints up $110,000 of counterfeit cash and outbids you for the house, he’s stolen your purchasing power.

My silly name-calling was "econo-religion" - I think a lot weaker than "theft and fraud". The gummint has the legal right to commit this theft and fraud. Not everybody shares your odd brand of morality, indeed what I think is morally imperative (deficit spending) is morally wrong in you eyes, for non-empirical reasons. In any case, in depression conditions, like right now, all you have to do is buy the house next to your counterfeiting-next door-neighbor's purchase, using the 100,000 you saved up, and laugh at him for overpaying. His printing money will not change prices. So he's richer. You both got the houses you wanted, and the previous owners are richer. Everybody is happy. Because again, the naive quantity theory of inflation is wrong.

Keynesian economics works. When the world was guided by Keynesian full employment policies, it got a lot richer, quickly. When it abandoned them, it grew much slower, and with most of the economic growth going to a bunch of rich fools.

An economy is a network of individuals striving to fulfill their wants and needs with limited resources.

Say an individual striving to fulfill his wants decides to build a bunch of houses to sell at a profit. He buys the materials necessary and with some labor builds a few. He later finds he is unable to sell them at a profit and takes a loss on them.

Have resources been allocated properly here? An individual bid resources away from other uses to build houses because he thought other individuals would be willing to pay more for them. He finds that they do not. He has created goods from resources that people are employing elsewhere at a profit.

Isn't this your understanding of how profit and loss in a market economy works to allocate resources? Losses on goods sold show that resources are not demanded for making these goods; profits show that resources are being utilized where people demand them.

Also, one question for you. Apparently you see Austrian economics as akin to religious doctrine. Can you provide the premise or premises that any Austrian economist has used in developing an economic theory that they have insisted be accepted on faith?

Well now. We’ve had admissions from Badtux that you can’t model micro behavior and that the nature of human will is a “religious” or philosophical question, meaning the issue cannot be decided with math. By the way Badtux, since you appear to dispute the idea of “free will”, what is your philosophical position on the nature of man’s will and also the Austrian theory of “acting man”? Must one use math to make the determination? Show your work.

The entire book is free online so you have no excuse in not refuting it in a detailed and scholarly manner.

We’ve also had the admission from Another Anonymous that when the government steals purchasing power from holders of existing money in order to pass out new funny money, that such a process is not really theft:

“gummint has the legal right to commit this theft and fraud. Not everybody shares your odd brand of morality, indeed what I think is morally imperative (deficit spending) is morally wrong in you eyes, for non-empirical reasons”

So, this is not a math problem either, but a moral and philosophical one. I note that even if the process is morally “OK” with AA, he doesn’t dispute that the process is really occurring. According to AA, purchasing power is being swiped surreptitiously from holders of existing money pursuant to a process that is morally fine because it is necessary and helpful. And gumints are just allowed to get away with swiping stuff. Just cuz.

Bob, religion is inherently the pulling of BS out of one's bunghole in order to explain things that human intellect is too feeble to currently understand. So there you have my philosophical objection to the subject as a whole. Religion is no more necessary to work economics than it is to work physics -- both have areas where it is provably impossible to create models that predict the exact behavior of individual particles, and it simply isn't necessary to pull BS out of your bunghole to predict things that are provably unpredictable.

The fact that you cling so tightly to your religion doesn't surprise me, I find that most of the religious do, but that doesn't make it anything more than made-up nonsense. Asking me to refute made-up nonsense is like asking me to refute the notion that God or the Great Penguin created the Earth from scratch 16,000 years ago by waving his hands or flippers and shouting Oooba gooba joooba squawwwwk! Uhm, you're the one who's making statements that you claim to be fact. Where's your evidence? Where's your numbers? Oh wait, like the young earth creationist you insist you don't NEED any numbers because your holy scriptures are Revealed Truth from your Holy Trinity of Mises, Hayek, and Rothbard (or Garrison in this case). Alrighty then!

Regarding purchasing power of money, your problem is that you don't believe in fractional reserve lending, much as the young earth creationist doesn't believe in the Big Bang. The fact is that the amount of money in circulation is going DOWN right now, because the reserve multiplier has effectively gone *negative*, and this is stealing purchasing power from buyers who lack money to buy and sellers who can't get enough money when selling in order to make a profit, and giving that purchasing power to hoarders -- but that's okay with you, because like the young earth creationist you can just put your hands over your ears and shout "I hear nothing! Mises strike you down for your heresy!"

Finally, I find it sad that you believe the amount of goods and services in an economy is fixed, and thus the only purpose of an economy is to move a fixed supply around. You must become completely discombobulated every time a new invention like the computer comes around that makes it possible to do amazing new things and add amazing value and efficiency to the economy, though of course you're not old enough to remember when computers were thousands upon thousands of young ladies in the Pentagon's basements cranking hand cranks as fast as they could in order to produce artillery tables with hand calculators. Now my cell phone has enough computing power to produce such artillery tables. Economies don't have to be static like in your sad model of an economy and as they grow, as more goods and services enter the economy, we need more money to match up with those goods and services or else we're stealing from the sellers by forcing them to sell at a loss. But wait, I forget, as long as we're not stealing from the hoarders, who cares? Alrighty, then!

Perhaps we should stop feeding the troll as s/he just admitted that labor and resources are not scarce, profits must be garunteed by money printing (heaven forbid the cost of living decrease with increasing productivity), and trade did not exist before an elastic fiat money supply was invented.

Wow, you guys just beat that stuffing out of the man of straw! You want to lie and pretend I said things I did not say? Uhm, dudes. Grow up. You "proved" Austrian economics is economics in the same way that the religious nut "proves" that Creation Science is science, and now are patting yourself on the back in self-congratulation? Gosh darn it, you guys sure feel proud of yourself for proving that your Holy scriptures are true and everybody else is a heretic who must burn on the fires of Hell.

But you are correct that there are certain things I *did* say that contradict your religious texts. Your religious texts hold that labor and resources are fixed, while I point out the simple reality that we have more labor and resources in today's economy than we had in the 15th century economy (dudes, that's not exactly amenable to argument, that's simply reality, like rocks falling when you drop them). Your religious texts say that the value of money should be allowed to increase because that is what creates economic growth. I *did* say that the value of money should be maintained by providing sufficient dollars for the economy so that producers can sell goods at a profit rather than at a loss, and that all periods of economic growth in our history have been during times when sufficient dollars have been provided for this purpose. Your religious texts say that economies worked better back before fractional reserve lending (which you guys hold is a "fraud") and hard currencies. I *did* say that yes, a capitalist economy with fiat currency simply works better than that system does. For perfect proof of that I don't have to do equations and other such silliness. I just have to turn on my computer. No other kind of economy ever produced computers. 'Nuff said.

So yes, there are things I *did* say that contradict your theology, that you can have differences with. But creating lies to stuff in my mouth in order to create a strawman for you to batter? Dudes. That's just childish stupidity, and makes you look like the biggest friggin' lying morons to ever walk this planet.

You wrote "I *did* say that yes, a capitalist economy with fiat currency simply works better than that system does. For perfect proof of that I don't have to do equations and other such silliness. I just have to turn on my computer. No other kind of economy ever produced computers. 'Nuff said."

This is a refutation of 100% fractional reserve banking? You have got to be kidding me. Google "post hoc ergo propter hoc fallacy."

( I do you enjoy your sense of irony though. I mean, you pick a thriving industry that offers better and better products at lower and lower prices year after year to make the case that the state must increase the money supply in order to compensate sellers. Really, truly, funny).

Richard, I am baffled. You claim that barring fractional reserve banking will result in an economic system (which I'll call "mercantilism" for lack of a better term, since it isn't capitalism) that is competitive with capitalism, which is inherently dependent upon fractional reserve banking in order to finance the capital equipment needed to produce future output using the revenue produced by that future output. Without fractional reserve banking the amount of money available for capital investment purposes is reduced by over 90%, which is why capitalism -- which inherently is based on fractional reserve banking -- has proven in the forge of history to be the most flexible and nimble way of matching supply and demand ever to evolve on this planet (I say evolve because capitalism evolved from earlier systems like mercantilism and won because it had evolutionary advantages based on its greater ability to adjust supply to meet demand, capitalism was not created from scratch or from the fertile imaginations of ideologues).

So anyhow, you claim that this mercantilist system that you propose ("100% reserve banking") will somehow be able to muster the financial wherewithall to build a $4 billion RAM plant, a $4 billion CPU plant, a $4 billion LCD display plant, and all the other *enormous* investments needed to produce a $500 computer. I can point to my computer and verify that a capitalist system produces all of those. Can you point to a single example anywhere in history of a mercantilist economy producing capital investments of anything approaching this scale? Curious penguins want an actual example, BTW, not hypotheticals pulled out of bungholes! My computer is on my desk. Where's your hypothetical mercantilist economy's computers (or equivalent-scaled investment)?

If I may restate your position based on previous comments you have made. You contend that the government needs to manage the money supply (i.e. create more money) in an expanding economy (one producing more goods and services) in order to ensure sellers are compensated. (I understand this as the standard ‘price stability’ position).

I pointed out that today the thriving computer industry (not to mention the thriving TV industry, thriving cell phone industry, etc.) produces better products at lower prices year after year.

You respond with a bunch of stuff about mercantilism, capitalism, fractional reserve banking, ‘financial wherewithal’, etc. I certainly can comment on all of that, and time willing, plan to do so in a future post, but I think this is a distraction from the issue at hand.

The issue being; how does a thriving computer industry producing better products at lower prices year after year square with your position that more money must be added to an expanding economy in order to compensate sellers (again, the standard ‘price stability’ position).

I see actual reality (sellers are compensated despite falling prices) clashing with your reality (sellers are not compensated if prices are falling). Given that you see yourself as ‘reality based’ I think you owe an explanation as to why you hold with your reality.

A chunk of silicon that held 1 transistor in 1970 holds 1,000,000 transisters today. Semiconductor manufacturing has literally become 1,000,000 times more efficient, which is why a CPU that would have cost $6,000,000 in 1970 would cost you $6 today (typical price today for embedded microcontrollers that have as much computing power as a $6M mainframe had in 1970).

In short, you're confusing price declines caused by increasing efficiency with price declines caused by increasing value of money. The former does not affect profitability of computer companies because they aren't required to sell goods for less than it cost to make them, indeed, Apple Computer recently turned in a record $14B quarter, and Intel recently turned in a record profit too, both caused by increasing their efficiency at creating goods. Monetary deflation, on the other hand, requires companies to sell goods for less than it cost to make them if companies wish to maintain volume, which clearly is a loss rather than a profit.

In short, your observation about supposed declining prices in the computer industry was incomplete. The per-unit price of a chunk of silicon is still pretty much the same as in 1970. All that has happened is that we need a lot fewer chunks of silicon to make a computer today than we needed in 1970, i.e., there is no actual price deflation in the computer industry, just an efficiency increase that allows spreading the price over more devices.

But we are more efficent at making everything now than we were 30 years ago, 100 years ago, etc. So if the money supply had remained constant or at least grew very slowly (i.e. gold, silver) the only 'price deflation' we would see is due to increases in productivity.

With an elastic money supply most of the increase in productivity is siphoned away from those who are actually productive to those with the politcal connections to get the freshly printed money first. Most people don't notice as long as their nominal wages keep up with the (cheery picked) CPI, but they have to be much more productive than laborers 30 years ago just to maintan the same standard of living. The money supply can increase by 10% or 100% but with increases in prodcutivity we may only see a 3% increase in CPI. This is part of the loss of purchaing power Austrains refer to.

Futhermore, a decrease in the money supply only becomes neccessary after an artifical expansion.

Rothbard’s point about malinvestments being cleansed and distortions being dealt with in periods of very high unemployment is total nonsense because this process takes place all the time anyway. In other words, even during periods of low unemployment, a thousand firms a day go bust in any decent size economy, and a thousand new firms start up.

I'm no economist, but it seems to me that are problems are that we don't actually make enough good and services that the world outside of us wants. Even our own businesses leave the country for labor because they can get it cheaper or better abroad. That's the real economic problem. All this stupidity about consumers saving instead of stimulating, or not enough demand is asinine. There's plenty of demand in the world, we're just not supplying it. If that's a malinvestment theory, than I say malinvestment is 100% correct.

About Me

I teach economics at Frostburg State University in Frostburg, Maryland. We are located on the Allegheny Plateau, and we have cool summers and tough winters.
I am the single father of five children, four of them adopted from overseas and I have two grandchildren. My family and I are members of Faith Presbyterian Church (PCA).